Tax Planning for an S Corporation

By Jeff Franco J.D./M.A./M.B.A.

If you incorporate or create a limited liability company (LLC) for your small business, you may be able to designate it as an S corporation for federal income and self-employment tax purposes. Most of the income tax planning for an S corporation will be of more use to a corporation than an LLC, but LLC members still stand to save a substantial amount of self-employment tax with an S corporation election.

If you incorporate or create a limited liability company (LLC) for your small business, you may be able to designate it as an S corporation for federal income and self-employment tax purposes. Most of the income tax planning for an S corporation will be of more use to a corporation than an LLC, but LLC members still stand to save a substantial amount of self-employment tax with an S corporation election.

Initial S Corporation Planning

All tax planning begins with the filing of IRS Form 2553 to make the S corporation election. You should make sure that you file Form 2553 no later than the 15th day of the third month of the tax year. By doing so, the IRS will allow you to treat the business as an S corporation for the entire year; otherwise, the election isn’t effective until the following tax year. However, in order to qualify for the election, the corporation or LLC cannot have more than 100 shareholders and must satisfy other requirements.

Ready to incorporate your business? Get Started Now

Avoiding Double Taxation

For most shareholders, the decision to make an S corporation election is done to avoid the double taxation that C corporations are subject to. A C corporation — which applies to all corporate entities that don’t make an S corporation election — is a separate and distinct taxpayer from its shareholders. This means that the business files a tax return, reports its taxable earnings and is responsible for paying all income tax. When the corporation makes a dividend payment, shareholders pay tax again despite the fact that the corporation already paid income tax on those distributed earnings. Planning to make an S corporation election is advantageous since the corporation eliminates the double taxation and is instead subject to pass-through taxation principles. Pass-through taxation allows shareholders to pay the income tax instead of the corporation. When the business files its tax return on Form 1120S, it also issues a K-1 to each shareholder to report his allocation of corporate earnings.

Shareholder Loss Deductions

A beneficial consequence of electing S corporation status for your entity is that, unlike C corporations, individual owners of the S corporation can reduce their personal income tax bill with losses from the business. For example, if the business is relatively new and incurs a significant amount of startup cost, the IRS allows owners who are more than just passive investors in the business to deduct these costs over a five-year period – even if it reduces the tax on earnings that are unrelated to the S corporation.

Salaries vs. Distributions

Members of an LLC can take advantage of pass-through taxation without making an S corporation election since the IRS automatically designates the entity as a partnership for tax purposes or as a sole proprietor if it's a single-member LLC. However, the income a member receives in both scenarios is subject to the self-employment tax. But by electing S corporation status, members can treat a portion of their earnings as profit distributions, which reduces the amount they will report as self-employment income. Corporate shareholders who provide services to the business can employ the same techniques as LLC members to minimize their self-employment tax bill.

Ready to incorporate your business? Get Started Now
Can an LLC File as a C Corp?

References

Related articles

LLCs Vs. S Corporations in Mississippi

If you are deciding whether to establish an LLC or an S corporation in Mississippi, you might not realize that you can actually have both. While there are certainly advantages to operating as an S corporation, it isn’t a business entity that you can create in Mississippi or any other state – an S corporation is merely an IRS tax election you can make for the LLC.

LLC Profits and Disbursement Rules

Owners who invest in a limited liability company and become members obtain returns on their investments through appreciation in the value of the business and through the earnings and profits of the LLC. The members may receive periodic distributions of LLC profits throughout the year. However, if members agree, the LLC may retain all earnings and refrain from issuing a distribution.

What Tax Forms Are Needed for an LLC?

Federal tax law does not provide specific rules that govern every limited liability company. Instead, the Internal Revenue Service allows members of a LLC to choose between corporate, partnership and individual taxation. The type of tax return in which you report the LLC’s income and expenses depends on the tax structure you choose to apply.

LLCs, Corporations, Patents, Attorney Help

Related articles

Taxation of an LLC

The Internal Revenue Code (IRC) does not impose a separate body of tax law that is applicable to limited liability ...

What Forms Do I Need to File for an S Corp?

An incorporated business is automatically designated by the Internal Revenue Service as a C corporation for income tax ...

Definition of a C-Corporation

Classification of a corporate entity as a C corporation rests entirely on whether it’s subject to the income tax ...

Can a Chapter C Corporation Carry Over to a Personal Tax Return?

Once you file the appropriate documentation to create a legal corporation in your jurisdiction, state and federal law ...

Browse by category
Ready to Begin? GET STARTED